Why the Bundesbank is wrong

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By Martin Wolf

.How far has the eurozone come towards resolving its crisis? The optimistic answer would be that it has rescued itself from a heart attack, but must still manage a difficult convalescence, with a good chance of further attacks. It must also adopt a regime able to protect itself against future crises. This task, too, is incomplete. But the eurozone has secured time. The big question is how well it now uses it.

.Arguably, the crucial step is to agree on the nature of the illness. On this, progress is now being achieved, at least among economists. It is widely accepted that the balance of payments is fundamental to any understanding of the present crisis. Indeed, the balance of payments may mattermore in the eurozone than among economies not bound together in a currency union. Hans-Werner Sinn of CESifo, in Munich, has done much to explain, in his words, that “the European Monetary Union is experiencing a serious internal balance of payments crisis that is similar, in important ways, to the crisis of the Bretton Woods System, in the years prior to its demise.” A special issue of the CESifo Forum, published in January 2012, is dedicated to this theme.

.In March, Bruegel, a Brussels-based think-tank, published a seminal paper on “Sudden Stops in the Euro Area”.Then, in late March, Jens Weidmann, president of the Bundesbank, explored the issue in a speech in London on “rebalancing Europe”..

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In the years of euphoria prior to the financial crisis, private capital flowed freely, not least into countries in southern Europe.Greece, Portugal and Spain ran current account deficits of 10 per cent of gross domestic product, or more. These financed huge excesses of spending over income in private sectors, public sectors, or both. These economic booms alsogenerated large losses in external competitiveness.

Then came the “sudden stops” in private inflows.As the Bruegel paper notes, such stops occurredduring the global crisis of 2008 (affecting Greece and Ireland), in the spring of 2010 (affectingGreece, Ireland and Portugal) and, finally, in the second half of 2011 (affecting Italy, Portugal and Spain). In some cases, what happened went beyond a mere stop in inflows. Ireland, for exampleexperienced large capital flight. Of course, when capital ceased to flow to the private sector, activity collapsed and the fiscal position worsened dramatically.

The eurozone was unprepared for such an interruption in cross-border finance: it was believed impossible. Once the stops had happened, the eurozone had twooptions: force external adjustment on countries shut out of the markets or finance them via official sources. The second was the chosen option, with the European Central Bank the dominantsource of finance, in its role as lender of last resort to banks. The ECB has become the “European Monetary Fund” (see charts).

So what is to be done?Mr Weidmandescribes what he calls a “typical German position”. This is that “the deficit countries must adjust. They must address their structural problems. They must reduce domestic demand. They must become more competitive and they must increase their exports.”

What, in this, is the role of the surplus countries? On this, Mr Weidmann is clear: “it is sometimes suggested that rebalancing should be undertaken by ‘meeting in the middle’, that is by making surplus countries such as Germanyless competitive.

.This suggestion implies that the adjustment as such would be shared between deficit and surplus countries.But the question we have to ask ourselves is: ‘where would this take us? . . . How can Europe succeed . . . if we . . . give up our hard-won competitiveness? To succeed, Europe as a whole has to become more dynamic, more inventive and more productive.”

Alas, these remarks confuse productivity with competitiveness.Yet these are distinct: the US, for example, is more productive, but less competitive, than China.

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External competitiveness is relative.Moreover, at the global level, the adjustment must also be shared. Mr Weidmann knows this. As he says, “of course, surplus countries will eventually be affected as deficit countries adjust”. The question is by what mechanism.

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The external competitiveness of the eurozone depends on the exchange rate.Yet that is not a policy variable. Members can only seek to improve their competitiveness vis a vis one another. That is exactly what Germany did in the 2000s. Now this must be reversed. Goldman Sachs has providedtwoexcellent pieces of research on what this might imply (“Achieving fiscal and external balance”, March 15 and 22). It concludes that, to achieve a sustainable external position, Portugal needs a real depreciation of its exchange rate of 35 per cent, Greece one of 30 per cent, Spain one of 20 per cent and Italy one of 10-15 per cent, while Ireland is now competitive. Such adjustments imply offsettingappreciation in core countries.

.Moreover, with average inflation of 2 per cent in the eurozone and, say, zero inflation in currently uncompetitive countries, adjustment would take Portugal and Greece15 years, Spain10 years and Italy 5-10 years. Moreover, that would also imply4 per centannual inflation in the rest of the eurozone.

Might such an internal adjustment even occur naturally?Yes, it might. At present, the ECB is pursuing an expansionary policy.At the same time, German bankssurely want to lend more at home.

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A huge lending boom in Germany would be a big help.But suppose that did not happen. Then today’s austerity-blighted eurozone would end up with a prolonged period of weak demand. It might, as a result, generate a large shift in its net exports. For the rest of the world, that would be a beggar-my-neighbour policy, impossible to tolerate in hard times. For the eurozone to pursue such a policy, while asking outsiders to increase their finance of its members in difficulty, via additional resources for the International Monetary Fund, would add insult to injury. The outsiders should just say no. They should insist, instead, that additional support must be predicated on two-sided adjustment inside the zone.

The good news is that agreement is emerging on the role in the crisis of the payments imbalances.The bad news is that the eurozone does not yet agree that competitiveness is necessarily relative. As soon as it does, the route to convalescence will at least be clear, however hard.

Germany is turning financial logic on its head.Government-bond yields hit
record lows Tuesday—with two-year yields even fallingbelow those of Japan. Yet
in many ways, Germany is booming.

.Unemployment, at 5.7%, is the lowest since reunification. Wage demands are
picking up, with the powerful IG Metall union seeking a 6.5% increase.
Real-estate prices in some cities are rising fast.

.And the economy, having
recovered from a deep recession, is holding up.Traditionally, that would be a
combination that signaled rising bond yields.Instead, they are plumbing new lows. Disappointing U.S. jobs data provided
the spur for the latest lurch down. But the renewed escalation of the euro-zone
crisis is a bigger and more persistent factor, driving those seeking safety into
bunds.On the face of it, German bunds look hugely overvalued.Euro-zone inflation
is expected to be 2.6% in March, well above the European Central Bank's target
of just below2%. A rule of thumb for 10-yearyields is that they should be
equal to expected nominal growth plus a modest risk premium; that would suggest
German bunds should yield more than 3%. Yet Tuesday, they were at 1.64%.
Two-yearyieldsfell as low as 0.09%, versus 0.12% for Japan..Germany is gaining at the expense of others, however. Spanish borrowing costs
are soaring, with 10-yearyieldsclose to 6%, up nearly1.4 percentage points
from their February lows. Italian yields are rising sharply, too. The ECB's
bond-buying programlooks like it is in hibernation, meaning there is little
check on higher yields. While the euro-zone firewall has been enlarged by
combining the European Financial Stability Facility with the new European
Stability Mechanism, both Spain and Italy are on the hook for large capital
contributions to the ESM. And yet both are in recession; Spain is grappling with
an 8.5%budget deficit, while Italy has debt of 119% of GDP. That may raise
doubts about the firewall's efficacy if it is truly tested.

.Germany has become effectively the only safe-haven government-bond market in
Europe, as the only large market with intact triple-A ratings. Politics in the
near term may increase bunds' allure. While French yields look far more
realistic, with 10-year bonds at 3%, investors nervous about the outcome of
France's presidential elections may prefer the safety of German debt. Greece's
May elections could yet provide headlines that unnerve the markets, given the
growing support for extremist parties. .Early March's move higher in global bond yields led some to declare the start
of a new bear market for bonds.On valuation grounds, investors may well have
doubts about German bunds. But fear of a new euro-zone blowup may well trump
those concerns—and drive German yields lower still..

Memo from Tokyo: what Japan can teach us

By Nick Pearce

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Dear Prime Minister,

.In 1977 Margaret Thatcher visited the Nissan car factory outside Tokyo.At the time, output per worker at Nissan was 400 per centhigher than at British Leyland, the largest UK carmaker. “It was so refreshing to see everyone working,” said Mrs Thatcher. “No one was standing around doing nothing.”

The rest is history.Nissan opened its car plant in Sunderland in 1986; today it employs more than 5,000 workers. UK factories make close to 1.5mvehicles a year, 80 per cent of which are exported. While Mrs Thatcher did more than any other politician to discredit the notion of active government intervention in the economy, her courtship of Nissan ranks as probably the single most important act of industrial strategy the UK has seen in the past 40 years.

As you reflect on your visit to the Nissan factory in Yokohama, you may recall this history.As you will remember, in the Thatcherera, Japan was believed by many to be on its way to becoming the world’s largest economy. Today it is often regarded as a stagnant, post-bubble economy, weighed down by public debt and an ageing society. But that is only a partial account, at best. In fact, Japan still has several policies from which the UK (and other countries) can learn a lot.

Over a fifth of the world’s patent applications in 2011 came from Japan, eight times as many as from the UK. It is far better at turning basic research into commercial applications, with clear national priorities set by government and strong links between businesses and universities. You should take a trip north to the Tsukuba Innovation Arena, with its state-of-the-art nanotechnology researchcentres.

.There you’ll see what the UK’s new Catapult centres for university-business collaboration could look like, given the right resources and dedicated facilities.

Japan’s manufacturing companies are kept lean by a strong yen but they still thrive on dense networks linking them to suppliers, banks and government agencies.The influence of these practices can be seen in the UK car industry, which has co-ordinated skills training for its manufacturers and their supply chains and a new Automotive Council to analyse future trends. Britain needs these kinds of partnerships in more industries.

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Similarly, just as Japan profited from public development and export banks in the postwar period, Britain would benefit from a national investment bank today, capitalising on historically low interest rates to fund investment in key sectors. You’ve made a start with theGreen Investment Bank but could be much bolder. (Indeed, if so minded, you would draw the lesson from Japan’s lostdecade that cutting a fiscal stimulus too soon after the bursting of an asset bubble can tip the economy back into recession and increase the risk of deflation.)

No one visiting Japan can fail to appreciate its world-class infrastructure, of which Shinkansen bullet trains are emblematic.In contrast, our creaking transport networks and ageing housing stock bear witness to the UK’s history of cuts to capital spending during periods of fiscal retrenchment. But the Japanese don’t just build infrastructure, they manage it within integrated systems, such as the one that controls all the power, signals, trains and passenger support for east Japan’s high-speed rail. Visit its control centre and you’ll see why none of the 27bullet trainsrunning when the earthquake struck in 2011 was derailed and no one has ever beenkilled in a high-speed trainaccident in Japan.

Onefinal thing: on the flighthome, find a bit of time to leaf through Project Japan, a history of the avant-garde Metabolist architects.It may offend your conservative aesthetic sensibilities but it’ll help you understand why Japanese citiesdo well in the rankings of the world’s most livable cities. Like us, the Japanese are an urban people living on a crowded island.

.Yet they have the ability to imagine the future and then to build it, often at breakneck pace.If we are to tackle our chronic housing shortage, we’ll need to bejust as bold.

Japan faces big challenges of its own, above all to increase immigration and boost its birth rate.But twice in its recent history, after the 1868 Meiji Restoration and the second world war, it proved itself capable of profound national modernisation. The question for you is whether Britain can do the same.

The inhabitants of a cluster of villages in the Medel Valley have shown themselves less than keen to dig the stuff out of their own mountains

Photo: Simona Fabrizio

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Photo: Simona Fabrizio

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8:00AM BST 08 Apr 2012

It was not a question many villagers will ever have to face - and theirs was an answer that even fewer would probably give.

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But when residents of a remote Alpine valley were offered a share of a fortune that would have brought themtens of millionsof pounds, they said "No".

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Swiss banks may be bulging with gold ingots, but the inhabitants of a cluster of villages in the Medel Valley have shown themselvesless than keen to dig the stuff out of their own mountains.

After months of anguished debate, the villagers voted in a referendum last week to stop a Canadian mining company prospecting for the estimated$1.2billionworth of goldore believed to be lie in seams beneath the surrounding snow-capped mountains.

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It would have been Switzerland's first gold mine and one of only a handful in Europe but locals ran scared of the prospect of turning their valley into a miniature version of the Klondike.

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In doing so they rejected a windfall of around40 millionSwiss francs (£27 million) over the next 10 years – a veritable bonanza for the 450 inhabitants of the picturesque valley.

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The debate sowed deep dissentamid the timber-clad homes and quiet streets of the villages dotted along the valley, where people speak Romansch, a language descended from the Latin of the Roman legions who conquered the region2,000 yearsago.

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."There was a battle between the two halves of the village, for and against the mine. Alot of peopledon't like to talk about it," said the owner of a delicatessenselling cheeses, cured meats and sausages, who refused to give her name because of the bitterness that has been stoked up.

.The referendum result was unambiguous – while 90 people were in favour of allowing gold exploration to go ahead, 180 were implacably opposed.

.Many people feared that the valley, with its crystal-clear streams, coniferous forests and timber barns, would have been irrevocably scarred by the mine, from which aroundfive million ton of rock would have been dug.

.The area is the epitome of Alpine tranquillity – when The Sunday Telegraph visited Curaglia, the largest single village, it was all but deserted, the quiet broken only by the tinkling of bells around the necks of goats in a wooden pen on the main street.

..Eagles soared in the mist swirling around the high peaks which form a dramatic backdrop to the onion-domed parish church.

.In winter the pass leading into the valley is frequently closed by avalanches and heavy snowfall."The mine would have had a big impact on the valley, there would have been a huge cost to the environment," said Nicole Venzin, 17, who works in a clothes shop in the town of Chur, 45 miles away, because of a lack of jobs in the valley.

.It was not just environmental worries that fuelled the 'no' vote. Young men in the villages worried that the 200 miners needed to develop the project might steal their girlfriends. Even the young women were unenthusiastic about the prospect of an influx of newcomers.

."It's very peaceful in the valley. But if the mine was allowed there would be a lot of cars, a lot of people."

.Lorena Bundi, 17, who works in a pharmacy, said: "There would have been more children in the school, and it would have been good for the shops, but what about the rivers where we go fishing?"

.But Thomas Boehm, 41, who works in the Hotel Vallastscha, which has the only bar and restaurant in the valley, said the mine would have reversed the valley's long-term demographic decline.Ninety of its inhabitants are over the age of 75 and young people leave as soon as they can because of the lack of work.

.There are no ski lifts or chalets and the only tourists who come here are fishermen, cross-country skiers and hunters in search of red deer and chamois.

."The mine would have been very positive.Look at this picture," he said, pointing at a black and white print of the village from 60 yearsago, showingtwo children in grubby smocks playing in an unpaved back alley lined with wooden-tiled houses.

."If nothing new happens here, the valley will go back to how it wasthen.There'll be no future for young people. The village is dying but people here are only thinking from one day to the next," said Mr Boehm, a German who has lived in Switzerlandfor 18 years.

.The mine would have been developed by a Canadian firm, Vancouver-based NV Gold.Some preliminary drilling in the 1980s, and more recent geological tests, showed that the snowy peaks overlooking the Medel Valley are rich in goldore. The tests showed that the local rock contained10 grams of goldper tonne, which is double the minimum for a viable mine.

.Nobody really knows how much goldthere is, or where a mine would have been sited, because the referendum result squashed the chance of any further exploratory drilling. But John Watson, the company's president and CEO, estimated that the mine could have yielded around 800,000 ounces of gold, which at today's prices would have been worth $1.2bn.

.The villagers would have received a share in royalties amounting to 30-40 million Swiss francs. There would also have been money spent by miners in shops and businesses during the estimated10 year life of the project.

.Local taxes and rates would have been slashed, businesses would have been offered cheap loans and there would have been bags of cash for new projects to inject life into the valley.

.Mr Watson said that past negotiations had led him to believe that the villagers would approve the mine unanimously at last Sunday's referendum.

."It would have had a very small footprint but it wouldn't have been invisible.It would have required parking lots, buildings, that kind of infrastructure.

."They were asking us what it would look like. We couldn't tell them with any accuracy because we haven't done the exploration and we don't know where the ore might be. Am I disappointed with the decision? Yes."

.The mine would not have been an open-cast scar on the valley."It would have been accessed by a tunnel into the mountain," said Mr Watson, speaking by telephone from Colorado.

.One of the mine's biggest proponents was Peter Binz, the mayor of the valley, whose eye for a business opportunity has been honed by his day job with PricewaterhouseCoopers in Zurich.

."The population is declining – there were 850 people living here in the 1960s – so we are lookingfor new opportunities.The mine would have brought fresh blood. We cannot stay as a museum – we need a future for our young people. To do nothing is not an option – that way we will just continue to die as a community."

.Such arguments failed to sway the majority of the valley's inhabitants.The conservatism for which the Swiss have been renowned for centuriesultimately snubbed out calls for change.

."The money would have been nice," said 17-year-old Nicole Venzin, sitting on a bench on Curaglia's main street as elderly womenentered the tiny supermarket with shopping bags."But what sort of future would we have if we ruined the environment?"

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.